Does Carr's Group (LON:CARR) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Carr's Group plc (LON:CARR) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Carr's Group

How Much Debt Does Carr's Group Carry?

The image below, which you can click on for greater detail, shows that Carr's Group had debt of UK£36.4m at the end of August 2020, a reduction from UK£49.5m over a year. However, it does have UK£17.6m in cash offsetting this, leading to net debt of about UK£18.9m.

How Healthy Is Carr's Group's Balance Sheet?

The latest balance sheet data shows that Carr's Group had liabilities of UK£70.8m due within a year, and liabilities of UK£42.4m falling due after that. Offsetting this, it had UK£17.6m in cash and UK£61.3m in receivables that were due within 12 months. So its liabilities total UK£34.3m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Carr's Group has a market capitalization of UK£115.6m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Carr's Group has net debt of just 1.1 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.3 times, which is more than adequate. It is just as well that Carr's Group's load is not too heavy, because its EBIT was down 29% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Carr's Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Carr's Group recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Carr's Group's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example, its interest cover is relatively strong. Looking at all the angles mentioned above, it does seem to us that Carr's Group is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. Given our hesitation about the stock, it would be good to know if Carr's Group insiders have sold any shares recently. You click here to find out if insiders have sold recently.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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